Dear Dr. Don,
I would like to put some of my Roth individual retirement account money toward my mortgage. My goal is to get rid of the private mortgage insurance premium. We have about $25,000 in the Roth IRA. Would this be wise?
The PMI is costing us about $110 a month. We are only into the third year of owning this house. Fortunately, we have other IRAs. Help! I don't know what to do.
-- Cindy Cancellation
You have plenty of company! Homeowners generally hate paying PMI on a conventional mortgage. That's partly because they're paying to protect a lender. At the same time, PMI allows a homeowner to purchase a home with something less than a 20 percent down payment. That raises the prospect of a lower mortgage rate and increased home-price appreciation.
The Homeowners Protection Act's standard for PMI cancellation is that the policy must be canceled when the loan balance is expected to reach 78 percent of either the market value or appraised value, whichever is lower, when the loan closed. That's based on the initial amortization schedule, subject to certain conditions. The act allows a homeowner to petition for cancellation when the loan balance is 80 percent of this value. The standard is based on actual payments. The law doesn't consider whether the property has increased in value in determining the percentages.
If the loan is held by Fannie Mae or Freddie Mac, they will take into consideration the property's value based on a current appraisal acceptable to the agency and the lender. You pay for the appraisal.
Since you're just three years into the mortgage, you'll want to be sure you can qualify for the PMI cancellation before raiding the Roth IRA. The mortgage loan servicer is required to notify you annually about the procedure to cancel PMI. Reach out to the servicer to learn about the requirements.
Should you tap into your Roth IRA to make enough of an additional principal payment that the mortgage servicer is required to cancel the PMI policy? It's tempting. You'll save $1,320 annually on PMI over the time the policy would have been in force. Plus, you save mortgage interest expense on the $25,000 payment.
There is a downside. There's the cost of the appraisal, as well as any taxes due from the early distribution. It also reduces your retirement savings a bit. Even so, all of these should be small impacts. Of course, you can use the savings from PMI to fund your retirement accounts.
Roth IRA contributions are made with after-tax dollars. Nonqualified distributions of Roth conversions and certain rollover contributions within a five-year period may be subject to the 10 percent additional tax on early distributions. For other Roth IRA contributions, nonqualified distributions aren't subject to the additional tax. Any early distributions of investment earnings, however, may be taxable and may also be subject to the 10 percent additional tax. Work with a tax professional if you're not sure of the tax impact of taking an early distribution or how to minimize the tax bill.